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Fiscal Analysis of a $500 Federal Education Tax Credit to Help Millions, Save Billions, Cato Policy Analysis No. 398

Fiscal Analysis of a $500 Federal Education Tax Credit to Help Millions, Save Billions, Cato Policy Analysis No. 398

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Published by Cato Institute
Executive Summary

On January 20, 2001, President George W.

Bush entered office committed to two main goals:

first, creating an education system that "leaves no

child behind" and, second, providing tax relief. By

adopting an education tax credit, the new president

could take a significant step toward accomplishing

both of those important goals.

The education tax credit under consideration

here has two components. The first is a parental

choice credit, under which any parent could

receive a dollar-for-dollar reduction in income-tax

liability of up to $500 per child for money spent

on tuition. The second is a scholarship credit,

which would raise funds for children in low-income

families. Under the scholarship program,

any individual could receive a dollar-for-dollar

reduction in income-tax liability of up to $500 for

donations to a nonprofit scholarship clearinghouse,

which would pair the money with needy

children, much as a highly successful program of

this kind does in Arizona.



In this analysis, we assume that every dollar spent

on the tax credit would result in a direct revenue loss

to the federal government, for a total cost of $9.2 billion.

At the state level, however, use of the tax credit

results in tremendous savings. By reducing the cost

of private schooling, the credit would encourage

some parents to transfer their children from public

to private schools. As students transfer, state governments

have fewer pupils to educate and can

reduce expenditures accordingly.



The parental choice component of the credit

could help approximately 330,000 new students

attend a school of their parents' choice, in addition

to making private schooling more affordable for

the millions of families with students currently

enrolled in private schools. We project an estimated

savings across the states of $2 billion, with significant

variation by state. Savings to taxpayers in

states such as California would be an estimated

$250 million; in states like New Mexico, an estimated

$8 million. We also find that the credit's

scholarship component could raise enough money

to give nearly 3 million students scholarships

worth $2,000 apiece. If 2 million of those scholarships

were used to move low income students from

public to private schools, taxpayers would reap $12

billion in savings. Taking both components

together, the parental choice and scholarship credits

would enable roughly 2.3 million new students

to attend a school of their parents' choice at a savings

across the states of $14 billion.
Executive Summary

On January 20, 2001, President George W.

Bush entered office committed to two main goals:

first, creating an education system that "leaves no

child behind" and, second, providing tax relief. By

adopting an education tax credit, the new president

could take a significant step toward accomplishing

both of those important goals.

The education tax credit under consideration

here has two components. The first is a parental

choice credit, under which any parent could

receive a dollar-for-dollar reduction in income-tax

liability of up to $500 per child for money spent

on tuition. The second is a scholarship credit,

which would raise funds for children in low-income

families. Under the scholarship program,

any individual could receive a dollar-for-dollar

reduction in income-tax liability of up to $500 for

donations to a nonprofit scholarship clearinghouse,

which would pair the money with needy

children, much as a highly successful program of

this kind does in Arizona.



In this analysis, we assume that every dollar spent

on the tax credit would result in a direct revenue loss

to the federal government, for a total cost of $9.2 billion.

At the state level, however, use of the tax credit

results in tremendous savings. By reducing the cost

of private schooling, the credit would encourage

some parents to transfer their children from public

to private schools. As students transfer, state governments

have fewer pupils to educate and can

reduce expenditures accordingly.



The parental choice component of the credit

could help approximately 330,000 new students

attend a school of their parents' choice, in addition

to making private schooling more affordable for

the millions of families with students currently

enrolled in private schools. We project an estimated

savings across the states of $2 billion, with significant

variation by state. Savings to taxpayers in

states such as California would be an estimated

$250 million; in states like New Mexico, an estimated

$8 million. We also find that the credit's

scholarship component could raise enough money

to give nearly 3 million students scholarships

worth $2,000 apiece. If 2 million of those scholarships

were used to move low income students from

public to private schools, taxpayers would reap $12

billion in savings. Taking both components

together, the parental choice and scholarship credits

would enable roughly 2.3 million new students

to attend a school of their parents' choice at a savings

across the states of $14 billion.

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On January 20, 2001, President George W.Bush entered office committed to two main goals:first, creating an education system that “leaves nochild behind” and, second, providing tax relief. Byadopting an education tax credit, the new presi-dent could take a significant step toward accom-plishing both of those important goals.The education tax credit under considerationhere has two components. The first is a parentalchoice credit, under which any parent couldreceive a dollar-for-dollar reduction in income-taxliability of up to $500 per child for money spenton tuition. The second is a scholarship credit,which would raise funds for children in low-income families. Under the scholarship program,any individual could receive a dollar-for-dollarreduction in income-tax liability of up to $500 fordonations to a nonprofit scholarship clearing-house, which would pair the money with needychildren, much as a highly successful program ofthis kind does in Arizona.In this analysis, we assume that every dollar spenton the tax credit would result in a direct revenue lossto the federal government, for a total cost of $9.2 bil-lion. At the state level, however, use of the tax creditresults in tremendous savings. By reducing the costof private schooling, the credit would encouragesome parents to transfer their children from publicto private schools. As students transfer, state gov-ernments have fewer pupils to educate and canreduce expenditures accordingly.The parental choice component of the creditcould help approximately 330,000 new studentsattend a school of their parents’ choice, in additionto making private schooling more affordable forthe millions of families with students currentlyenrolled in private schools. We project an estimat-ed savings across the states of $2 billion, with sig-nificant variation by state. Savings to taxpayers instates such as California would be an estimated$250 million; in states like New Mexico, an esti-mated $8 million. We also find that the credit’sscholarship component could raise enough moneyto give nearly 3 million students scholarshipsworth $2,000 apiece. If 2 million of those scholar-ships were used to move low income students frompublic to private schools, taxpayers would reap $12billion in savings. Taking both componentstogether, the parental choice and scholarship cred-its would enable roughly 2.3 million new studentsto attend a school of their parents’ choice at a sav-ings across the states of $14 billion.
Fiscal Analysis of a $500 Federal EducatioTax Credit to Help Millions, Save Billions 
by Darcy Ann Olsen, Carrie Lips, and Dan Lips
 _____________________________________________________________________________________________________
Darcy Ann Olsen isdirector of education and child policy at the Cato Institute; Carrie Lips, a former policy analysat the Cato Institute, ispursuing a mastersdegree in public policy at the John F. Kennedy School of Government at Harvard University; Dan Lipsiseducation research assistant at the Cato Institute.
Executive Summary
No. 398May 1, 2001
 
Introduction
Looked at from any number of perspectives,it is clear that America’s system of K–12 school-ing is leaving many children behind. Twenty-five percent of U.S. students haven’t graduatedfrom high school by age 18, and the nation’shigh-school seniors score below teenagers inalmost every other developed country on math-ematics and science tests.
1
Since the 1970s, perpupil expenditures have doubled, class sizeshave shrunk, and teachers’ salaries have grown.Despite those spending infusions and count-less other reforms, student achievement hasstagnated and even declined.
2
Americans are increasingly dissatisfied withthe quality of public schools, and most thinkprivate schools offer a better education than dopublic schools.
3
Concomitant with those senti-ments is a growing belief that parents shouldhave more control over the selection of theirchildren’s schools. A recent CNN/USA Today/ Gallup poll found that 54 percent of Americanssupport policies that provide parents with agreater choice of schools.
4
There is good reason to believe parentsshould have more control over their children’seducation: more than a dozen studies havefound that school choice programs increaseparental involvement and have a positiveimpact on student achievement.
5
And morethan half of parents say that, if cost were notan issue, they would prefer to send their chil-dren to a private or parochial school.
6
Policymakers attempting to satisfyparental demand for choice are increasinglyconsidering using education tax credits.Among other benefits, education tax creditsreduce the cost associated with choosingindependent and parochial schools andthereby enlarge the pool of schools availableto parents.
7
Education tax credits or deduc-tions exist in 4 states, and at least 7 state leg-islatures considered adopting education taxcredits in 2001.
8
For the purpose of this analysis, weassume that every dollar spent on the taxcredit results in a direct revenue loss to thefederal government, for a total cost of $9.2billion.
9
At the state level, however, use of thetax credit results in revenue savings.
10
Byreducing the cost of private schooling, theeducation tax credit would encourage someparents to transfer their children from publicto private schools. As students transfer to pri-vate schools, the government has fewerpupils to educate and can reduce educationexpenditures accordingly.The parental choice component of thecredit could help approximately 330,000 newstudents attend a school of their parents’choice, in addition to making private school-ing more affordable for the families of themore than 5 million students currentlyenrolled in private schools.
11
We project anestimated savings across the states of $2 bil-lion, with significant variation by state.Savings to taxpayers in states such asCalifornia would be an estimated $250 mil-lion; in states like New Mexico, an estimated$8 million. We also find that the credit’sscholarship component could raise enoughmoney to give nearly 3 million studentsscholarships worth $2,000 apiece. If 1 millionof those scholarships assisted low-incomechildren who are currently enrolled in privateschools, there would still be enough revenueto help nearly 2 million additional children.Under this scenario, as nearly 2 million newstudents moved from public schools to pri-vate schools, taxpayers would reap $12 bil-lion in savings. All together, the parentalchoice and scholarship credits would enableroughly 2.3 million new students to attend aschool of their parents’ choice at a savings totaxpayers of $14 billion.
The Proposal
The proposal under consideration is a$500, nonrefundable education creditagainst the federal income tax. This credithas two components. The first piece is aparental choice credit, under which any par-ent could receive a dollar-for-dollar reductionin income-tax liability of up to $500 per child
2
By effectivelyreducing the costof private school-ing, the creditwould encouragesome parents totransfer theirchildren frompublic to privateschools.
 
for money spent on tuition at a nonpublicschool. The tax credit would provide a directreduction of an individual’s tax liability. Forexample, let’s say that Chris owes $1,000 infederal income tax. Because he sends one ofhis children to a private school, Chris is eligi-ble for the $500 parental choice credit. Hesubtracts the $500 tax credit from the $1,000tax liability and now owes $500 in federalincome tax.The second component is a scholarshipcredit, which would raise scholarship fundsfor children in families with little or noincome-tax liability. Under the scholarshipprogram, any individual taxpayer
12
couldreceive a dollar-for-dollar reduction inincome-tax liability of up to $500 per taxpay-er for donations to a scholarship clearing-house.
13
The scholarship organizationswould then pair scholarships with needy chil-dren, thereby enabling families with noincome-tax liability to choose alternativeschools for their children. A similar scholar-ship tax credit in Arizona led to the creationof an estimated 35 scholarship clearinghous-es and raised almost $14 million for scholar-ships in just one year.
14
Our analysis assumesthat, like the Arizona model, the scholarshiporganizations are nonprofit, under sec.501(c)3 of the Internal Revenue Service Code,and distribute 90 percent of their revenue asscholarships.
15
If taxpayers spent money on tuition fortheir own children and also donated moneyto an education scholarship fund, they couldclaim both components of the tax credit aslong as the combined amount did not exceedtheir tax liability. Likewise, a parent might beable to use the parental choice credit and stillbe a scholarship recipient, depending onscholarship eligibility requirements.
16
As a practical matter, implementing thetax credit would require the establishment ofvarious administrative procedures. Such pro-cedures could include the following: (1) mod-ify individual tax forms to provide a conve-nient way for taxpayers to claim the credit, (2)provide for a standard receipt, showingtuition payments, to be issued to parents byschools, thereby allowing parents to claimthe proper credit, (3) provide for a standardreceipt to be issued by scholarship organiza-tions to donors, thereby allowing donors toclaim the proper credit.Judging by Arizona’s experience with itstax credit, administering the credit should befairly simple. Arizona law is silent on mostadministrative issues beyond the require-ment that 90 percent of donations be distrib-uted as scholarships. However, since thescholarship organizations are nonprofit,501(c)3 organizations, they follow somestandard procedures. According to Arizona’soldest scholarship organization, the ArizonaSchool Choice Trust, once ASCT receives acontribution, the trust issues a receipt to thedonor and informs him of the availability ofthe tax credit. To make sure the money isused to fund scholarships and that the trustcan prove that to potential auditors, ASCTasks schools to certify attendance and tuitionpayments. ASCT also requires parents to signa document stating that the scholarship willbe used for a private K–12 school.
17
Projecting the Impact of theTax Credit
Variables
The projected impact of the universal edu-cation tax credit on federal and state budgetshinges on several important variables. Thetwo most important are the rate at which tax-payers will use the credit and the attendantincrease in demand for private schooling asthe costs associated with choosing alterna-tive schools decline.For the purpose of this analysis, weassume that every dollar spent on the taxcredit results in a direct revenue loss to thefederal government. At the state level, however,use of the tax credit results in revenue savings.By reducing the cost of private schooling, theeducation tax credit would encourage someparents to transfer their children from publicto private schools. As students transfer to pri-vate schools, the government has fewer
3
A similar scholar-ship tax credit inArizona led to thecreation of anestimated 35scholarship clear-inghouses andraised almost $14million for schol-arships in justone year.

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